".r N."

s&,. INSTITUTE OF INDUSTRIAL RELATIONSUNIVERSITY. OF CALIFORNIA.

LOS ANGELES 90024

( WORKING PAPER SERIES - I-..

1.

WHO HAS FLEXIBLE WAGE PLANS ANDTHERE MORE OF THEM?

119

WHY AREN'T

by

Daniel J.B. Mitchell* and Renae Broderick**

V

*Daniel J.B. MitchellDirectorInstitute of Industrial RelationsU.C.L.A.Los Angeles, California 90024(213) 825-4339

and

ProfessorGraduate School of ManagementU.C.L.A.

**Renae BroderickAssistant ProfessorGraduate School of ManagementU.C.L.A.Los Angeles, California 90024(213) 825-4728

Draft: October 1986-NTfiSTRIAL

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WHO HAS FLEXIBLE WAGE PLANS

AND WHY AREN'T THERE

MORE OF THEM?

Renae BroderickAssistant ProfessorGraduate School of ManagementU.C.L.A.Los Angeles, California 90024(213) 825-4726

Daniel J.B. MitchellDirectorInstitute of Industrial

RelationsU.C.L.A.Los Angeles, California 90024(213) 825-4339

and

ProfessorGraduate School of ManagementU.C.L.A.

Paper for the December 1986 meetings of the Industrial RelationsResearch Association in New Orleans.

October 1986

CONTENTS

I. Types of Plans .......................................... p. 1

II. Surveys of Plan Usage .................... p. 4

III. Management Attitudes .................... p. 4

IV. The Question of Substitutability . .............. p. 6

V. Public Policy Implications .............................. p. 7

VI. Conclusions ......................... p. 8

Footnotes .............................................. p. 9

Tables 1 and 2 follow page 4

Tables 3 and 4 follow page 6

There has been renewed interest in "flexible" compensation

plans in recent years. Some of this interest is due to concerns

about poor U.S. productivity performance. Some of it stems from

theoretical analysis by Weitzman and others suggesting that

macroeconomic problems (unemployment, inflation) could be

alleviated by certain kinds of flexible pay systems.'

Four types of plans are commonly lumped under the

flexibility label. These are 1) simple incentives such as piece

rates, 2) gain sharing plans (Scanlon, Rucker, Improshare), 3)

employee stock ownership plans (ESOPs, tax-credit ESOPs), and 4)

profit sharing plans. Unfortunately, discussion of these plans

is frustrated by lack of consistent, basic data on the extent to

which these plans are actually used. Moreover, the tendency to

lump the plans together obscures their differences.

In this paper, three issues are examined. First, available

evidence is examined concerning the use of flexible pay systems.

Second, management beliefs about the attributes of the plans are

explored, based on a survey conducted by the authors. Third, the

question of perceived substitutability between the alternative

plans is discussed, using the survey. This last question is

important due to the Weitzman argument that all plans are not

created equal. If having one type of plan precludes having

another, then it will be difficult to encourage establishment of

those plans which have desirable economic properties.

I. TYPES OF PLANS.

Simple incentive plans began as piece rates in early

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manufacturing settings. Such plans still exist. But as

scientific management developed in the early part of this

century, more elaborate systems evolved (Bedaux, Halsey, Rowan,

and Gantt plans). A typical plan involves a production standard

with worker bonuses for meeting or exceeding the norm.

Compensation specialists often argue that simple incentives

provide the greatest potential for productivity improvement,

since the rewards are tied to individual performance and are

frequently made (each paycheck). However, in many circumstances,

especially for white collar workers, lack of a clearly measurable

output makes such plans infeasible. Questions of quantity vs.

quality may be raised, even where tangible output exists.

Finally, there are well known problems with the dynamics of

standard setting, especially the (perverse) incentives created

for workers to restrict output in order to keep norms low.

Simple incentive plans do not receive favored tax treatment

since incentive pay is taxed as current income. From an economic

perspective, this treatment is reasonable. If these plans do

improve firm performance, they are likely to be adopted without

tax preferences. In the Weitzman view, simple incentives do not

foster external macroeconomic benefits. Without such social

externalities, tax preferences are unwarranted.

Gain sharing Plans in contrast, because they are often based

on value added or sales, may yield Weitzman-type benefits.

(Whether they do or not depends on the bonus formula used). Like

simple incentives, gain sharing receives no preferred tax

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treatment. Gain sharing systems generally involve bonuses based

on labor cost savings at the plant or firm level. Because these

programs are group oriented, they are viewed by proponents as

devices to improve teamwork and general job satisfaction. The

formulas used to determine gain sharing bonuses are complex.

Employee stock ownership plans involve creation of a trust

which holds company stock for employees. ESOPs have received

increasingly favorable tax treatment since the mid 1970s on the

theory that they spread wealth and turn workers into mini-

capitalists. However, the plans do not produce Weitzman-type

external macro benefits.- In principle, ESOPs can be used to

provide a vehicle for 100% worker ownership. Such ESOPs are

rare, but often well publicized.

Tax credit ESOPs (TC-ESOPs) -- most recently known as

PAYSOPs -- enjoyed an implicit tax subsidy which exceeded 100% of

their costV! 3 The amount of employer "contribution" permitted was

quite limited. Revisions of the tax code in 1986 removed the tax

subsidy for PAYSOPs.

Finally, profit sharinq plans link bonuses to company

profits. Those plans that pay cash bonuses receive no tax

preferences. If the plan provides for deferred benefits , i.e.,

paying the bonus into a retirement fund, employee tax liability

is deferred. However, the implicit tax subsidy is no greater

than provided under qualified pension plans and deferred savings

arrangements such as 401(k) programs. Yet if profit sharing

plans offer the macroeconomic external benefits suggested by

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Weitzman, they have the best claim on preferential tax treatment

of any of the flexible pay systems.

II. SURVEYS OF PLAN USAGE.

Table 1 summarizes information from four major surveys which

relate to flexible pay. Other data sources are also available,

but there is no comprehensive survey providing detailed

information on the number and characteristics of employers and

employees involved in such pay systems, or on the employer

expenditures involved." Based on the limited data available, the

following conclusions can be reached.

Incentive plans still are used with some frequency,

especially in situations where output is easily measured.

However, they appear to have declined in popularity over the long

run and in recent years.5' Gain sharing plans are so rare that

they must be regarded as curiosities. Profit sharing plans cover

no more than a fifth of private employees.

Data on employee stock ownership can be misleading. Most of

the workers covered by such plans had TC-ESOPs, not "regular"

ESOPs. TC-ESOPs were likely to be found at larger firms where

personnel managers understood that the U.S. government was paying

for them. With the tax subsidy now removed for TC-ESOPs, more

attention will be focused on regular ESOPs (which cover only a

small proportion of workers). Regular ESOPs enjoy a considerable

tax subsidy, especially when used as financing tools.

III. MANAGEMENT ATTITUDES.

A recent survey of private sector management attitudes

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Table 1

Flexible Compensation Plans: Major Data Sources

1) Bureau of National Affairs, Basic Patterns in Union Contractstriennial survey of 400 union contracts. Reports one third ofcontracts have simple incentives, concentrated in manufacturing.

2) Bureau of National Affairs, Productivity Improvement ProQrams1984 survey of 195 employers. 19% have profit sharing, 18% haveemployee stock ownership, 1% have Scanlon, 1% have Improshare,40% have performance bonuses, 10% have piecework.

3) General Accounting Office, Employee Stock Ownership Plans,special survey of 4,200 ESOPs and TC-ESOPs based on IRS reportscovering 7 million workers as of 1983. 90% of these employeesare under TC-ESOPs.

4) Bureau of Labor Statistics, Employee Benefits in Medium andLarge Firms. Annual survey covering over 42,000 establishmentswith 23.1 million workers. In 1985, 18% of covered workers hadprofit sharing, 2% had ESOPs, 22% had TC-ESOPs.

Table 2

Characterization of Flexible Compensation Plansby Survey Respondents

Profit Tax Credit Gain SimpleSharing ESOP ESOP Sharing Incentive

Best for:Raising productivity 28% 5% * 26% 41%Increasing loyalty 48 17 2% 19 14Providing forretirement income 80'. 13 7 n.a. n.a.

Linking labor coststo firm performance 53 n.a. n.a. 28 19

Easiest to:Explain to employees 32 9 7 4 49Administer 40 7 12 4 38

n.a.=not asked.*Less than .54.'Refers to tax-deferred profit sharing plans.

Based on 508 surveys returned as of October 15, 1986 frompersonnel/IR managers.

toward flexible pay systems for nonexempt employees was conducted

by the authors."- Personnel/IR managers were asked about the use

of such systems in their firm and about their views of such plans

(regardless of use). The survey produced a wealth of data which

can only be highlighted in this report.

Management attitudes toward flexible pay are summarized on

Table 2. Generally, the respondents believed that of the five

flexible pay systems listed on the table, simple incentives were

the best productivity enhancers and were the easiest to explain

to workers. Profit sharing was seen as providing flexible labor

costs to the firm, increasing loyalty, and (in the deferred form)

providing a useful retirement program. Gain sharing was viewed

as more complex to administer and explain than the other plans,

but as having a beneficial effect with regard to productivity,

loyalty, and labor cost flexibility.

TC-ESOPs were not highly rated. Undoubtedly, part of the

reason is the extremely limited employer "contribution" that was

permitted by Congress for these plans. However, regular ESOPs

also do not show up well in the relative rankings of Table 2.

Proponents, of course, can cite numerous case studies in which

benefits did accrue from the use of ESOPs. And the purpose of

this essay is not to dispute those findings. The issue is rather

one of alternatives, particularly since Congress has focused its

favors on the ESOP and its variants.

It might be noted in this connection that about one fourth

of the sample respondents were employed by firms with ESOPs. Yet

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they were not significantly more likely to rank the ESOP approach

as best with regard to productivity and loyalty. ESOP users were

more positive than others about the use of ESOPs for retirement

savings and to their ease of administration and explanation. But

they still rated other plans as better on these dimensions.

IV. THE QUESTION OF SUBSTITUTABILITY.

In principle, employers can have a mix of flexible

compensation systems; having one plan does not necessarily

preclude also having another. But employers might not chose to

mix the plans if they believed that one was sufficient to meet

their objectives. Based on the survey it is possible to ask two

questions: 1) What does management believe about the

substitutability or complementarity of flexible pay plans? 2)

What does management do with regard to mixing such plans?

Table 3 reports on findings related to attitudes (as opposed

to practices). Respondents were asked whether they agreed or

disagreed with the proposition that having one type of specified

plan made it unnecessary to have some other specified plan. It

is most useful to concentrate on the findings with regard to

profit sharing, ESOPs, and simple incentives, since TC-ESOPs have

lost their tax preferences and gain sharing is so rare.

Obviously, there are some managers who feel that having an

ESOP precludes having profit sharing. This view is stronger

among those who have ESOPs than among others. But even among

ESOP users, only one fifth take this position. About a sixth of

the managers in firms with simple incentives believe that such

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Table 3

Management Attitudes Concerning Plan Substitutability

Percentage of Respondents Generally or Strongly Agreeingthat Having One Plan Obviates Need for the Other

Firm doesn'tneed -->

if ithas:

Profit Sharing

CashBonus

TaxDeferred ESOP

TaxCred i tESOP

GainSharing

Profit sharingCash bonus _ n.a.Tax deferred n.a. -

ESOP 16 (20) 15 (19) _Tax credit ESOP 13 (6) 12 (4) 23 (23)Gain sharing 28 (43) 23 (27) 13 (6) 9 (10)Simple incentive 17 (17) 14 (14) 5 (2) 5 (4) 24 (24)

n.a. = not asked.Based on 508 surveys returned as of October 15, 1986.Percentages refer only to those answering the question. Figuresin parentheses refer to respondents whose firms had the planapplicable to the table row.

Table 4

Effect of Having Alternative Plans onIncidence of Profit Sharing and ESOPs

Profit Sharing ESOP

Type of Do Not Do NotRespondent: Have Plan Have Plan Have Plan Have Plan

All Respondents 52% 46% 25% 75%With ESOP 54 46 _ _With profit

sharing - - 25 75With tax credit

ESOP 48 52 33* 67*With gain

sharing 48 52 16 84With simple

incentive 58 42 28 72

*Significant difference indicated by Chi-squared test betweenthose with and without tax credit ESOPs. (Chi-squared = 11.658).

Based on 508 surveys returned by October 15, 1986.

|~~~~~~~~~~~

incentives obviate the need for profit sharing. No relationship

is seen between ESOPs and simple incentives. Stated attitudes,

in short, are not barriers to adopting more than one plan.

Information on actual practice is presented on Table 4. The

table shows the proportions of respondents who report their firms

have (or do not have) profit sharing plans and ESOPs. Partly

because of the sample design, and partly because of response

bias, the proportions having profit sharing and/or ESOPs are much

higher in the sample than in the general population (as discussed

in Section II above). About half of the respondents report

having profit sharing programs and about one fourth have ESOPs.

Generally, having another flexible pay system does not have

a statistically significant effect on the chance that the

respondents' firms also had profit sharing or ESOPs. The only

significant association reported is that those with TC-ESOPs were

more likely also to have regular ESOPs. Presumably, knowledge of

operating one type of plan was helpful in operating the other.

V. PUBLIC POLICY IMPLICATIONS.

Of course, there is another kind of substitution possibility

which is not reflected in the survey. Congress has made certain

choices in targeting its tax expenditures in the flexible pay

area. Specifically, with the 1986 tax law revisions, it has

chosen to favor ESOPs over all other arrangements.

In the past, this preference was attributed by many

observers to the influence of Senator Russell Long. With Long's

retirement, however, it is unclear why this preference--

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particulary for ESOPs over profit sharing -- should continue.

Based on the analysis of Weitzman and others, it is profit

sharing which has the greater claim for a social subsidy due to

its potential macroeconomic benefits.

VI. CONCLUSIONS.

The title of this paper asked who has flexible compensation

and why aren't there more of them. Within the (severe) limits

imposed by data availability, the first question has already been

answered. As to the second, the following responses can be given.

Simple incentives exist where output can be measured and

where firms believe they can overcome some of the administrative

and perverse incentive problems such programs entail. Gain

sharing is perceived to be difficult to explain and administer

(compared with other plans), so its use is extremely limited.

TC-ESOPs existed only because of extreme Congressional

beneficence. Regular ESOPs seem also to depend on Congressional

favoritism; even so, they are not very widespread.

Finally, profit sharing is seen as inferior to simple

incentives if the objective is just to raise productivity. But

it receives good overall ratings from managers and can be (and

is) used in conjunction with incentives. Recently, profit

sharing has made inroads into the unionized sector of the economy

in autos, steel, telephone communications, and lumber. If

Congress chose to reorder its preferences, use of profit sharing

could be extended.

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FOOTNOTES

1. Martin L. Weitzman, The Share Economy: Conqueringi Staqflation(Cambridge, Mass.: Harvard University Press, 1984).

2. This issue cannot be explored here. Essentially, the problemwith ESOPs is that employees take their benefits with them whenthey leave the firm (in the form of shares or a cash payment fortheir shares). Under profit sharing, however, departingemployees receive either nothing or -- under deferred plans--their past bonuses. See Daniel J.B. Mitchell, "The Share Economyand Industrial Relations: Implications of the Weitzman Proposal,"Industrial Relations, forthcoming.

3. U.S. Office of Management and Budget, SDecial Analyses: BudQetof the United States Government, Fiscal Year 1987 (Washington:GPO, 1986), pp. G29-G30.

4. Interested readers may wish to refer to publications of TheESOP Association, the Profit Sharing Council of America, theProfit Sharing Research Foundation, the National Center forEmployee Ownership, and the U.S. Chamber of Commerce for examplesof available information.

5. Norma W. Carlson, "Time Rates Tighten Their Grip onManufacturing Industries," Monthly Labor Review, vol. 105 (May1982), pp. 15-22.

6. The survey consisted of a mail questionnaire sent topersonnel/IR managers whose names appeared on mailing lists ofthe UCLA Institute of Industrial Relatioons, the IRRA, theInternal Revenue Service, and the American CompensationAssociation. Information about this survey can be obtained fromthe authors and will appear in other forums.

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